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The Economic Approach to
Environmental and Natural
Resources, 3e
By James R. Kahn
© 2005 South-Western, part of the Thomson Corporation
Part III
Renewable Resources and
the Environment
Chapter 15
Water Resources
© 2004 Thomson Learning/South-Western
Introduction
 In the history of the United States, water has always
played an important role, but it was not viewed as
scarce.
 Water was abundant in the East and even though
much of the West was semiarid it did not limit the
growth of the population.
 Because water use in the US was not been managed
to prevent or mitigate increasing scarcity, as we
moved into the latter part of the 20th century,
important water problems developed.
 This chapter examines the growing scarcity of water
resources in the US and the world and examines
policy to address this scarcity.
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Introduction
 Four distinct problems have arisen that affect the
availability of water.
 First, in many areas of the country the use of water
exceeds the rate at which it is being replenished.
 Second, many activities use water as an input, and
when the water is returned to surface or
groundwater, its quality is diminished.
 Third, many activities use surface or groundwater as
a means to dispose of waste, creating water quality
problems.
 Fourth, degradation of ecosystems weaken their
ability to store water and modulate the drought/flood
cycle.
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Hydrological Cycles
 The hydrological cycle refers to the movement of
water from the atmosphere to the ground and then
its evaporation and return to the atmosphere.
 Water vapor in the atmosphere condenses and falls
to the ground in some type of precipitation (rain,
snow, sleet, etc.).
 Some of the precipitation lands directly in surface
water and some on land.
 In the United States, on average, 66 percent of the
precipitation returns to the atmosphere directly by
evaporation; 31 percent runs off to rivers, streams
and lakes; and 3 percent seeps underground.
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Hydrological Cycles
 Forests and other terrestrial ecosystems play a very
important role in the hydrological cycle.
 Leaves and stems of trees break the impact of the
rain, slow its decent, allowing more of the moisture
to be absorbed in the ground.
 Additionally water flows down the trunk of the tree
and continues along the roots deep below the
ground.
 The net effect of the forest is to allow more of the
rainwater to become groundwater and less to
immediately enter streams and rivers.
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Nutrient Cycling
 The nutrient cycle refers to how the basic nutrients
(nitrogen, potassium, and phosphorous) move
through the ecosystem.
 When organisms die and decay, the nutrients are
released in the soil or water and become available to
plants, which absorb them.
 The plants are then eaten by other organisms that
absorb the nutrients and the cycle continues.
 Problems arise when additional organic wastes from
human activity are introduced into the ecosystem.
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Nutrient Cycling
 Processes that break wastes down into basic nutrients also
remove dissolved oxygen, essential for aquatic life, from the
water.
 In addition, nutrients can contribute to algae blooms that block
light from penetrating the water.
 When the algae die, their decay further contributes to the
decline in dissolved oxygen.
 If all the oxygen is depleted, then the decay process shifts from
bacteria that operates in the presence of oxygen to bacteria
that operates in the absence of oxygen, which leads to the
"rotten egg" smell associated with polluted waters.
 Agricultural run-off, suburban run-off, paper plants, food
processing, stock yards, and discharge from sewage treatment
plants are among the most significant anthropogenic sources
of nutrients.
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Water Consumption
 As you recall from Chapter 1, within the resource taxonomy
there are three categories:
 renewable resources, in which the stock regenerates itself,
 resource flows, where a never-ending flow comes from a
nondepletable stock and
 exhaustible resources.
 Water, in general, meets the definition of a renewable resource,
where the evaporation from the oceans and other water
sources creates the precipitation that replenishes the oceans.
 Water in riverine systems can be viewed as a resource flow.
 Some water resources can be viewed as exhaustible because
the rate of growth of the stock is small in relation to the use of
the water.
 "Fossil water," which is water that has accumulated slowly in
underground aquifers over millions of years is an example of
an exhaustible resource.
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Water as an Input to Production and
Consumption
 If the flow of a river is much larger than the
withdrawals of water to meet consumptive and
productive needs, and if uses of water are benign,
then there will be no resource allocation problem,
even if the water is available at zero cost.
 However, if the flow of water is not capable of
meeting all needs at any point in time then a
shortage will develop.
 At a price of zero, quantity demanded of water is
greater than amount available and as price rises, the
least valuable needs will be left unsatisfied.
 If price is continually raised, eventually quantity
demanded will equal the amount of water available.
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Water as an Input to Production and
Consumption
 Figure 15.1 illustrates how essential scarcity is in
determining price.
 In this figure g0 represents the daily volume of water
that may be removed from the river.
 The cost of extraction is zero.
 Demand is represented by D1.
 Under these circumstances, all the demand that
exists at zero price will be satisfied.
 However, if Demand increases to D2, all the demand
at zero price cannot be satisfied.
 As demand increases, the opportunity cost of
consuming the fixed flow of water increases, which
is reflected in the increased price.
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Water as an Input to Production and
Consumption
 Property rights must be well defined in order for a
market and a price to exist.
 Price will also reflect the marginal cost of producing
water.
 The cost of producing water takes the form of
purification, transportation, etc.
 If property rights are not well defined or other
conditions result in market failure, then the price will
be too low and this will lead to shortage as
illustrated in Figure 15.2.
 Here, the price at which quantity demanded equals
fixed quantity supplied is p0, but a price of p1 would
lead to a shortage equal to g1-g0.
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Water as an Input to Production and
Consumption
 In eastern and Great Lakes states, water resources
can be viewed primarily as resource flows, where
most cities and agricultural areas depend on surface
water or groundwater that is generally replenished
by normal rainfall.
 One mechanism that often leads to urban water
problems is the process by which water is priced
and distributed to customers.
 This is usually done by either a regulated water
utility or a municipal water company.
 In both cases there are political or regulatory forces
that push the price of water below its opportunity
cost.
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Water as an Input to Production and
Consumption
 When water is provided by a regulated monopoly,
the monopoly is allowed to charge a price that yields
a reasonable rate of return on their capital
investment.
 The scarcity value of water is not incorporated into
the price, only the scarcity value of the other inputs
used in purifying and distributing water.
 If the price of water is below the opportunity cost, a
shortage will develop and other means will have to
be used to allocated the water.
 There is no guarantee that these alternative methods
will result in an efficient allocation of the water.
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Water as an Input to Production and
Consumption
 Alternatively, if a city elects to provide distribution of water as a
city service, political pressures may keep rates low, again
allowing no mechanism for reflecting the value of alternative
uses.
 When consumers of water in an apartment building pay a rate
based upon use by the entire building (average price) rather
than an individual rate (marginal price) there is no strong
incentive to conserve use.
 Even if water is priced according to marginal willingness to
pay, there may still be market failure if the pricing structure
does not reflect the ecological opportunity cost of water.
 Two basic ways to reflect the ecological opportunity cost of
water include a government tax on water use or the purchase of
water rights by NGOs where the water is left in the stream.
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Water as an Exhaustible Resource
 Water resources in western states are better described as
exhaustible resources particularly in those states overlying the
Ogalla Aquifer and other slowly recharging aquifers.
 The economic analysis of water as an exhaustible resource is
very similar to the analysis of water as a resource flow, only
there is an additional opportunity cost.
 The first opportunity cost is the cost of not having water for
another current use, the contemporaneous opportunity cost.
 The second is the opportunity cost of not having the water
available for future use, which results from current use
depleting the stock available, which is called the intertemporal
opportunity cost.
 An efficient allocation of water would require that the price
reflect both contemporaneous and intertemporal opportunity
cost.
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Water and Property Rights
 In the United States property rights to water are a big
issues in the Western US where most rights are
defined on a state-by-state basis.
 Appropriation-based water rights make water
available for use by anyone who can apply it to a
beneficial purpose.
 Priority goes to the user who establishes his or her
appropriation-based rights first.
 Initially these rights were nontransferable but
increasing demand for water has led western states
to make them transferable.
 This has created a market for water and the potential
to use market mechanisms to protect ecological
uses of water.
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Degrading Uses of Water
 There are three types of uses that degrade water quality.
 The first is when removal of water from surface water bodies or
groundwater aquifers generates ecological damage.
 Heavy water withdrawal in the coastal area of southern Florida
has lead to saltwater intrusion into the aquifer.
 The second is when a direct consumer of water uses it and
returns it to hydrological cycle with wastes and contaminants.
 An example would be residential use of water which adds
human wastes: even when treated, the water has a higher level
of nutrients which can cause ecological damage.
 The third type of use is represented by activities that generate
wastes that are directly deposited into or make their way
through natural mechanism such as run-off from rainfall.
 An example would be rainfall run-off that carries pesticides
from agricultural fields.
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US Policy Toward Water Pollution
 U.S. policy toward water pollution has historically focused on
large point sources of pollution.
 Point sources of pollution are those where the pollution enters
the water body at a specific point, such as the end of an
effluent discharge pipe.
 One of the major thrusts of attempts to reduce water pollution
was a program to reduce the impact of the discharge of
municipal sewage.
 As late as the 1960s, many small cities did not have a water
treatment plant and dumped raw sewage directly into rivers and
lakes.
 This time period also saw inadequate treatment in the larger
cities and as a result, there was severe degradation of virtually
every river that flowed through a metropolitan area. Lake Erie,
which was particularly hard hit, became incapable of
supporting aquatic life.
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US Policy Toward Water Pollution
 Amendments to the Clean Water Act required all municipalities
to develop and upgrade their sewage treatment facilities.
 This included both primary (removal of suspended particles)
and secondary treatment (breakdown of organic wastes).
 Programs were designed so that the federal government would
pay 75 percent of the costs of the facility, and the local
government would be responsible for the remainder of the
construction costs and for operating costs.
 The primary reason for the federal government involvement
was that the social benefits to the nation of treating a
community’s wastewater was greater than the social benefits to
the community.
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US Policy Toward Water Pollution
 Because the federal government subsidized
construction but not operation of these
facilities, local governments tended to favor
a capital intensive design which lead to a
non- optimal mix of inputs in production.
 Construction of these plants were completed
in the 1970s and they had a rapid effect on
water quality.
 One result was the recovery of many of the
polluted river systems, including Lake Erie.
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US Policy Toward Water Pollution
 The subsidized improvements in municipal sewage treatment
plants were required by the Water Pollution Control Act of 1972,
the Clean Water Act of 1977, and 1977 and 1978 amendments to
the Clean Water Act (CWA).
 These acts, based on command and control techniques, also
focused on other large point sources of pollution, such as
paper plants, food processing facilities, and other industries.
 The National Pollution Discharge Elimination System (NPDES)
made all discharges illegal unless authorized by NPDES.
 Polluters were required to use best practical technology (BPT)
for conventional pollutants and best available technology (BAT)
for toxic pollutants.
 BPT allows for the consideration of cost of the technology, BAT
does not.
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US Policy Toward Water Pollution
 Economic incentives have not been employed to deal with
water quality problems.
 While it would be feasible to develop a system of marketable
pollution permits, it would require more interstate cooperation,
since all the major river systems span several states.
 The use of command and control policies created the same
types of problems discussed earlier in Chapter 3.
 The Clean Water Act and associated amendments have not
been completely successful in meeting the legislative goals of
restoring and maintaining the chemical, physical, and
biological integrity of the nations’ water.
 There has been some mixed success in reduction of organic
wastes from point source polluters.
 However, where nonpoint pollution is a major problem, the
water quality remains poor.
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US Policy Toward Water Pollution
 Nonpoint source pollution, is associated with agricultural,
urban, and suburban run-off.
 Recently new regulations have been developed requiring
farmers to institute "best farming practices" to control nutrient
run-off and soil erosion.
 Agriculture remains one of the largest contaminators of water
resources in the parts of the US and in developing countries.
 Even though some progress has been made in controlling
organic pollutants, the problem of toxic pollutants has not been
similarly reduced.
 Many areas with healthy fishing populations also have
prohibitions against consumption of the fish due to the high
levels of contamination by toxins such as PCBs, mirex, dioxin,
and heavy metals.
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International Water Issues
 The water problems in other countries (particularly developing
countries) may be more severe than in the United States.
 The primary water problem in developing countries is the
contamination of water by untreated human waste.
 This is true not just in villages, but also in very large urban
areas such as Rio de Janeiro, where large slums intensify the
waste problem.
 This is not just a third world problem. In the Po River Valley in
northern Italy, many cities (including Milan) dump untreated
wastes into the river.
 The Mediterranean Sea suffers from extreme water pollution
problems which are expected to increase as North Africa
becomes more industrialized.
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Transfrontier Externalities
 One of the major problems associated with water extraction
and water pollution in Europe, Asia, Africa, and Latin America is
transfrontier externalities.
 The water consumption and waste disposal activities of one
country affect water availability and water quality in
neighboring countries.
 This is particularly true in the Middle East, where
geographically small countries overlie common aquifers and
where rivers such as the Jordan River and the Tigris-Euphrates
River drain several countries.
 These transfrontier externalities cannot be internalized without
international agreement.
 The United States has longstanding agreements with Canada
concerning water use and water quality in boundary areas, and
a special commission to deal with Great Lakes issues.
 Agreements with Mexico are being developed.
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Agriculture and Water Quality in
Developing Countries
 Problems with deforestation, over-tillage, tillage of hillsides,
heavy use of dangerous pesticides, and run-off of fertilizer has
seriously affected water quality in many developing nations.
 One of the most degrading uses of water is the irrigation of
agricultural fields because irrigation can lead to the rapid
depletion of groundwater and reduced flows in rivers.
 In addition, repeated soaking of the soil and the evaporation of
the water in the soils draws salts from lower levels of the soil
and deposits them in the top layers of the soil, where they
adversely affect many of the crops.
 Large withdrawals from a river can result in destruction of the
aquatic systems, which is the case for the Aral Sea in the
former Soviet Union, where the flow of the river draining into
the sea was reduced so much that the fisheries within the sea
were destroyed.
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Summary
 Although the earth’s surface is three-quarters
covered by water, uncontaminated water is a scarce
resources.
 Many market failures, including externalities,
nontransferable property rights, and poorly
conceived regulatory practices contribute to the
scarcity.
 From a US and international perspective, one
critically important policy change would be to price
water so that it included its full opportunity cost.
 This would include the opportunity cost of both
current and future uses of water, as well as the costs
associated with reductions in the quality of water
resources.
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